As a potential angel investor, your position is unique. Maybe the market is booming, leaving you flush with excess cash that you can deploy in a variety of startups that inspire you. Or maybe we’re hitting a recession - but that still leaves reasons for angels to be optimistic - some of the world’s largest companies were started in recessions, including PayPal and Youtube.
Market recessions and pullbacks often create extraordinary and favorable conditions for angel investing - as we’ll see later in the article. That means you can still see massive returns on your investment.
But to maximize the angel investor rate of return, you need to understand a few basics about different types of returns.
Today, you'll understand the financial and non-financial returns you need to consider in your investment decisions.
Let's get started with the basics…
An angel investor is a private investor, angel funder, or seed investor who backs a small startup or an entrepreneur financially. The investment is typically in exchange for ownership for equity in the business.
In some cases, angel investors are friends and family using their funds to invest in businesses. In other cases, angel investors are operators, or people interested in the start-up ecosystem, who want to support the ecosystem and learn along the way. As an angel you get a unique perspective into how entrepreneurs are building the businesses of tomorrow or building products of tomorrow.
The average angel investment is $300k per deal, but this average disguises that some angels are making investments as small $500 and as large as multi-millions For the smaller check investors, often they are using syndicates to pool money with other investors, so that they can invest a smaller amount but still get exposure to high potential start-ups.
But what is the difference between a business angel and a venture capitalist?
Although they share a common goal to provide capital to businesses for startup or expansion, they also have some distinct differences to note:
Angel investing is profitable but can also be very risky. Some angel investors report returns higher than 10X their initial investment after selling their stake in the business.
So, what do angel investors get in return?
Generally, they expect to get their money back on their portfolio within 5 to 7 years with an annual internal rate of return (IRR) of 20% - 40%. This timeframe is starting to get longer, with the average time to exit for companies getting longer. Most angels are now comfortable with a 5 to 12 year period before liquidity.
However, some angel investors invest for impact/learning. For these angels, what they get in return is an opportunity to help the founders build their business and to help the company avoid common pitfalls along their journey. They also get the opportunity to learn about how these early stage companies are being built. Another thing that angels can get in return is the satisfaction of contributing to a social change (e.g. climate tech companies, or underrepresented founders). For these angels, they are often less focused on financial returns.
And that’s what we look at next...
One of the angel investors' motives for investing in risky startups and early state businesses is that they can potentially earn a greater financial return.
The investor's required rate of return is usually greater than they can get from investing in bonds, stocks, and mutual funds.
So we’ll look at both financial and non-financial returns.
Most experienced angel investors expect more than 31-40% annual returns on their early-stage and startup investments. When looking at an investment, ask yourself whether this investment can achieve those returns and more over the time of the investment. Also consider the operation of the Power Law and the need for this company to be an outlier.
A well-diversified angel investment portfolio has an average annual return of 25-30% - that's 2 or 3 times better than the money you'd make by investing in the S&P 500.
The angel investor return on investment (ROI) is expressed as a percentage using the following formula.
ROI = (Profit - Investment Amount) / Investment Amount X 100
To annualize your ROI, just simply divide your total ROI by the number of years you invested in the company for.
Angel investors make their money by exiting or participating in secondaries, and that means selling their equity ownership positions.
But angel investors expected return on investment is seldom the only benefit they are looking for. Some prefer the non-financial benefits of investing in private businesses.
Now we know angel investing can produce a better return than the stock markets.
Plus, many angel investors also choose businesses based on their social impact. According to the Harvard Business School Survey, angel investors are more likely to invest in strong social impact companies.
Stock market investments are highly liquid. You can take your money back at any time if you want to. But you're powerless because stock market investments limit you to buying, selling, and waiting - you have little influence over the outcomes.
Angel investing is different - it gives you more influence and more potential to learn. While you still can’t control the outcome, if you have a good relationship with the founders, you can support the company to have the best outcome possible. It is very important that you don’t become an overbearing angel - the company is run by the founders and you are there to support them, not run the business for them.
Smart angel investors use their power to steer their investee company towards success.
Here is how you can add value to companies that you already support financially.
Are you an expert in digital marketing and have helped other companies grow using your skills?
When you invest in a startup struggling to gain market traction, would you just watch helplessly and hope they'll figure it out?
Angel investing enables you to use your expertise in a particular industry or technology you gained during your career.
Here's the thing. Choose to invest in a company where you can add more value other than just your money. Be smart money. That's what many business owners also want from their investors - especially at their earliest stages.
For example, you can act as an advisor to the founders and chief executives. Your unique perspective can help identify the business's weaknesses that those close to it may be blind to.
Facilitating connections between startup staff and your key contacts is invaluable.
Your connections could help bolster a business in all stages of growth. Recruiting key talent can be the hardest part of building business, and your network may be invaluable to the company’s growth.
Your professional and personal contacts could help fill in another round of funding or other business leads.
Either way, your contact list is immensely powerful and can transform a small operation into a galloping project with a global reach.
Your wealth, work, and wisdom contribution will increase your chances of a more favorable exit and build your desirability as an angel investor.
Supporting a social cause is a non-financial reward and an integral part of the deal evaluation process. Some social motivations may include;
You may want to invest in an industry you want to learn more about. For example;
Even though money is your bottom line, founders will reward supportive angel investors more by letting them into future deals and giving you great references for future deals you want to do.
More support...more satisfaction...and more money.
That's the power of investing more than just your money.
Maximizing angel investment returns can mean more than one thing.
Just like any investment class, diversification is key. A ten-investment portfolio stands a better chance of making returns of 20% yearly or more than a one investment portfolio.
How much money to invest in each startup…all depends on what you're comfortable with.
Most angel investors set aside between 5-10% of their net worth for angel investing. However, some experienced angel investors invest much more. It's ultimately your decision.
You can spread your maximum and annual investment amount across ten or more funding opportunities annually. Investing small amounts into a diverse portfolio can be better than investing a huge chunk of money in one company. One method to get this spread is to invest smaller amounts into syndicates through platforms like Angelist.
Global markets became chaotic during the 2019-2021 coronavirus pandemic. Industries that were doing exceptionally well suddenly took a nose-dive...and companies that were tanking went wild to meet the demand.
But some angel investors have hit the jackpot...during the coronavirus pandemic.
Prof. Timothy Springer invested $5 million into Moderna several years ago… and today, his stake is worth over $800 million. That's about a 17,000% gain.
Here is the thing. Moderna is a biotech company based in Massachusetts, and their COVID-19 vaccine was one of the first to show promise. The Fed invested more than $400 million to develop the product.
Now, Moderna's stock is up more than 60%, and investors are rejoicing.
Angel investing remains one of the best ways you can build your personal wealth while contributing to interesting ideas, the growth of the economy and your knowledge and expertise in an area - all at the same time..
Dr. Timothy Springer is not only an immunologist but now very wealthy.
Even if you don’t come across that jackpot, you can make your own success by knowing your non-financial success criteria.